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Offline mhr

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BitAssets Article
« on: April 24, 2015, 03:57:54 PM »

I am writing an article about BitShares, with a focus on BitAssets.  More specifically, the article will focus more on the financial arrangements of BitAssets than on the technical arrangements.  The objective of my article is to explain the BitAssets arrangement for the layman.  This means that I may use a hyper-simplistic approach to describing BitAssets, so that people with no trading experience, and people with no economics background can understand the concepts involved.

There are many people on this forum who are quite sophisticated, and I do not want to insult anyone's intelligence.  However, I may ask some very basic questions in the course of my research, and belabor some fundamental concepts in an effort to understand BitAssets well enough to break it down for the uninitiated reader.

I have read Bytemaster's Blog, and I believe that I have a basic understanding of BitAssets, but I still have some questions about the arrangement.  I have to first be sure that I understand BitAssets before I can explain it to others.  I will start by considering the purely financial aspects of BitAssets, meaning those aspects that are completely independent of technology; those aspects that could have existed five hundred years ago.  To convey the spirit of my article, I will begin with some descriptions of conventional trading arrangements.

Loans / Bonds

A loan is an arrangement in which one economic actor lends an asset to another economic actor for a period of time, at a rate of interest.  The borrower will generally offer a receipt for this loan, and that receipt is sometimes referred to as a bond, a note, or a bill.  Oftentimes, we hear people say things like, “I am going to buy government bonds.”  Government bonds have been around for eons, and everyone basically understands that government bonds are government debt instruments.  When a person “buys government bonds”, he is not really buying anything.  What he is really doing is lending money to the government.  In response, the government issues a receipt for the loan.  The receipt explains the terms of the loan: duration, interest, etc.  This receipt is referred to as a bond (or a note or bill).  In conventional parlance, no one belabors the definition of a bond, and people routinely use (slightly) incorrect terminology (such as “buying bonds”), but it doesn't matter, because everyone basically understands how a bond arrangement operates.  Nonetheless, in explaining bonds to a middle school or high school student, a proper definition would need to be offered.

exempli gratia:  Alice lends 10,000 US dollars to the government.  Over a defined period of time, the government pays back to Alice her principal of 10,000 USD, plus a defined interest percentage in USD.  (Notice that there is only one asset, USD, involved in this trade.  For the purposes of this explanation, we are not defining the receipt (bond) as an asset, even though these receipts are transferable.  Also, notice that there are two parties to this trade, Alice and the government.)

Short Sales

A short sale is another long-standing, though creative, means of trading assets.  A short sale is different from the loan example given above, as a short sale involves two different assets, whereas the loan arrangement mentioned above only involves a single asset, USD.  Also, a short sale involves a sale, whereas the loan arrangement mentioned above does not.

A short sale is a financial arrangement by which one can profit from a decline in the price of one financial asset as compared against the price of another financial asset.  In a short sale, a trader borrows an asset from another individual (with appurtenant terms of duration and interest being ignored for the purposes of this discussion; we can consider cost of carry at a later time), then immediately sells that asset into the open market.  That is to say that he trades his borrowed asset for some other asset.  After some time, the borrowed asset (hopefully) has declined against the asset it has been traded for.  At this time, the trader can purchase back the borrowed asset at a lower cost than he sold it for, and give the comparable asset back to the original lender, thereby closing out his short position.  He pockets the difference in the price he sold the asset for, and the price he bought the asset back for (minus interest, but we will ignore that for now).

e.g.:  Bob borrows 10 ounces of gold from Alice.  Bob immediately sells the 10 ounces of gold to Charlie.  That is to say that Bob immediately trades the 10 ounces of gold for some amount of (for example) USD.  Let's say that he trades the 10 ounces of gold for 10,000 USD, as that is the going rate in the open market.  Let's say that, after some time, the price of gold against USD has fallen by 40%.  This means that Bob can trade back only 6,000 of his USD to acquire the 10 ounces of gold that he originally borrowed.  Bob trades 6,000 USD to Dave, in exchange for 10 ounces of gold.  Bob then gives Alice back her 10 ounces of gold (plus interest, but we are ignoring that for now), and he pockets the additional 4,000 USD that he acquired in the trade.  He has closed out his short sale for a 4,000 USD profit (minus interest).  (Notice that the short sale involves two separate assets: gold and USD.  Notice also that there are four parties to this trade: Alice, Bob, Charlie, and Dave.)

Loans Denominated in Other Assets

Let's consider a third, less common arrangement.  It is possible to lend an asset with the terms of the loan denominated in a second asset.  (Again, we will temporarily ignore the duration and interest considerations of the loan for the sake of clarity.)  As an example, one may lend 100 dollars' worth of gold.  This means that the asset lent is gold, while the asset which denominates the loan is USD.  Like the short sale arrangement mentioned above, this financial arrangement involves more than one asset, and, as such, it also allows for a profit or loss to either trading party, based upon a change in the price relationship between the two appurtenant assets.

e.g.:  Alice lends Bob 10,000 USD worth of gold.  In response, Bob issues to Alice a receipt (bond) which details the terms of the loan.  Let's say that, at the time of the loan, 10,000 USD is equal to ten ounces of gold.  Let's say gold rises against the USD to twice its previous value.  Bob closes out his loan position with Alice by paying her back 10,000 USD worth of gold at the new exchange rate (plus interest, but we are temporarily ignoring that), and Alice cancels the receipt (bond) detailing Bob's debt to her.  This means that to pay back the appropriate amount of gold, Bob only has to pay Alice back five ounces of gold (plus interest).  Bob pockets the other five ounces of gold as profit.

Alice loses value on this trade, but, had the exchange rate varied in the opposite direction, Bob would have had to pay Alice back more gold than he originally borrowed from her.  (Notice that there are again two assets involved in this arrangement: gold and USD.  Notice also that there are only two parties to this trade, Alice and Bob.)

Carry Trades

I had said I would ignore interest and duration for the time being, but I can't seem to help myself, so I'll go ahead and describe carry trades.  An interest rate is sometimes referred to as a cost of carry.  Carry trades are basically subsets of short sales that focus on the different going interest rates for different assets.  As in two of the examples above, a carry trade involves more than one asset.

A carry trade is a short sale in which a trader borrows an asset at interest, immediately sells that asset for a second asset, and then lends the second asset at a higher interest rate.  To close out a carry trade, the trader calls in his loan of the second asset (plus interest), uses the recalled second asset to buy back the borrowed asset, and pays back the borrowed asset (plus interest).  The primary profit motive of a carry trade is to pocket the interest proceeds of the lent asset, which are hoped to exceed the interest costs of the borrowed asset.  Of course, there being two assets involved in the trade, profits or losses can also accrue to the trader if the asset price relationship between the two assets changes during the trade.  So, we can see that a carry trade is a trade that involves two separate assets with two separate profit/loss potentials (primarily, interest rate arbitrage across two assets; and secondarily, asset price ratio changes).

e.g.:  Alice lends Bob 10 ounces of gold at 1% interest.  Bob immediately sells the gold to Charlie for 10,000 USD, and lends the 10,000 USD to Dave at 5% interest.  After one year, Bob calls, from Dave, his loan of 10,000 USD (plus 500 USD interest),  buys, from Erin, 10.1 ounces of gold (at a price of 10,100 USD), returns the 10.1 ounces of gold to Alice as principal plus interest, and pockets the 400 USD as profit.  (Notice, in this example, that there are two assets traded, gold and USD.  Also notice that there are five parties to this trade: Alice, Bob, Charlie, Dave, and Erin.)

Comparisons

From the four debt-based trading examples given above, we can see that financial arrangements can involve only one asset, or they can involve more than one asset, and they can involve profit/loss potential from a change in price ratios, and also from interest considerations.  When only one asset is involved, the lender will typically rely solely upon an interest charge to profit from the arrangement.  The borrower will be happy to pay this interest rate, because the borrower's desire for capital is greater than his aversion to the interest rate.  However, when more than one asset is involved in a financial transaction, the exchange rate fluctuations between the multiple assets transacted can be a source of profit or loss in addition to the usual interest rate charges.  Finally, in some arrangements, there is profit/loss potential derived from the different going interest rates for different assets.  So, a financial transaction involving one asset can be viewed as a simple financial arrangement, and a transaction involving more than one asset can be viewed as a compound transaction.  Compound transactions allow for short sales, creative loan denominations, and carry trades, all of which improve price discovery and price stability in mature markets.

Mexican Restaurant Menu

I'll use a Mexican Restaurant Menu analogy to demonstrate how one can categorize recipes or other constructs.  When one visits a Mexican restaurant, at least if he is not Mexican, he may be confused by the multitude of different items on the menu with exotic names.  If the patron does not frequent Mexican restaurants, he may not know the difference between a tamale, a burrito, a tostada, a chalupa, a quesadilla, a flauta, and a chimichanga.  Certainly, understanding the differences can be difficult to the uninitiated restaurant guest.  However, an experienced waitress can usually clear up the confusion with some categorical assistance.  Most Mexican restaurant menus involve dishes consisting of the following options:

1.  Corn or flour tortilla
2.  Soft or hard tortilla
3.  Chicken, pork, beef, or fish
4.  Rice, beans, or rice and beans
5.  With cheese or without cheese

When one is not certain whether he would prefer a tamale, a burrito, a tostada, a chalupa, a quesadilla, a flauta, or a chimichanga, he may prefer to instead consider the options enumerated above and make a decision, based upon that list.  Likewise, when one is considering different debt instruments, he may alleviate confusion by breaking the arrangements into their constituent parts.

Debt Instrument Menu

As we saw from our earlier analysis of the various debt instruments offered in conventional markets, debt-based trades tend to involve the following options:

1.  Number of parties to trade (two, four, five?)
2.  Number of assets traded (one single asset, or multiple assets?)
3.  Number of profit/loss potentials (interest alone as a profit potential; or interest, exchange rate fluctuations, and interest rate arbitrage?)
4.  Simple or complex trade?  Interpolated trades such as sales or loans within the overall trade?

From this short categorical list, we can analyze the debt instrument menu to discover which categories the various trades fall into.

BitAssets

Based upon my current understanding of BitAssets, I am inclined to think that the financial arrangement listed above, which most closely approximates the BitAssets arrangement, is the third arrangement, which I called “loans denominated in other assets”.

There has been much discussion likening the BitAssets arrangement to that of a short sale, but I believe that BitAssets is more akin to a loan denominated in another asset.  Obviously, a BitAssets transaction involves two assets (for example, BitShares and USD), so that separates BitAssets from the first arrangement of a simple loan.  In a short sale, an asset is borrowed, and immediately sold.  This selling action is missing from the BitAssets transaction, and therefore separates BitAssets from being a short sale.  However, in the BitAssets arrangement, a trader may borrow a certain dollars' worth of BitShares, wait for BitShares to appreciate against the USD, and then pay back some portion of the BitShares to close out his loan, and pocket the remainder as profit.  I don't believe that a short sale is the proper characterization of the arrangement, as there is no sale involved; only a loan.

e.g.:  Bob borrows from Alice 10 USD worth of BitShares (which happens to be 10,000 BitShares).  Bob issues a receipt to Alice (or bond, herein referred to as BitUSD), stating the terms of the loan (though we are ignoring interest for the time being).  BitShares doubles in price versus USD.  Bob returns 10 USD' worth of BitShares to Alice (now amounting to 5,000 BitShares), and Alice cancels the BitUSD which Bob had issued to her as a receipt, thereby closing out the loan.  Bob pockets the other 5,000 BitShares as profit.  This trade involves two assets, but it does not involve a sale.  Also, this trade involves two parties, Alice and Bob.  This leads me to believe that BitAssets is basically a loan for which the denominating asset (USD) is different from the lent asset (BitShares).

So, the first question I would like to ask of the BitShares community is whether I have the appropriate understanding of how the BitAssets arrangement is structured.  Also, I would like feedback about any errors and omissions.  Please remember that, in asking this, I am more interested in understanding the financial structure of the arrangement than I am interested in the technical, digital structure of the arrangement.  Thank you for your consideration.

Offline donkeypong

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Re: BitAssets Article
« Reply #1 on: April 24, 2015, 04:04:43 PM »
In the history of the BitShares Forum, that's one of the best first postings I've seen by a new member (unless, of course, you changed your name). Welcome and good luck with your article.

Offline bytemaster

Re: BitAssets Article
« Reply #2 on: April 24, 2015, 04:10:36 PM »
They are easily understood by the existing financial sector as Exchange Traded Contract For Difference
For the latest updates checkout my blog: http://bytemaster.bitshares.org
Anything said on these forums does not constitute an intent to create a legal obligation or contract between myself and anyone else.   These are merely my opinions and I reserve the right to change them at any time.

Offline mhr

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Re: BitAssets Article
« Reply #3 on: April 28, 2015, 02:36:12 AM »
Donkeypong, thank you for the generous compliment.  Bytemaster, thank you for the prompt reply.

Let's analyze Contracts for Difference a bit more thoroughly.  Contracts for Difference are bets that traders place on the price action of securities or commodities.  Contracts for Difference are no longer legal in some countries, such as the United States, but they used to be legal many decades ago.  At the time, they were not called Contracts for Difference, but they were just called bets.  These bets were placed in houses called “bucket shops”, and this type of trading was described at length by Jesse Livermore in the book Reminiscences of a Stock Operator.  This is a famous book, one of the “trader's bibles,” that is very informative and very entertaining.  Everyone interested in BitAssets should take some time to read this book.
https://en.wikipedia.org/wiki/Reminiscences_of_a_Stock_Operator

There are different arrangements of bets or contracts for difference, and we can analyze a couple of them here.  As Livermore described, in the late 1800s and early 1900s, there were bucket shops in which traders could place bets on the price action of shares traded on the major stock exchanges, such as the New York Stock Exchange.  When a trader placed a bet in a bucket shop, no orders were placed on the actual stock exchanges.  Instead, the bucket shop would collect the price of shares from the trader, and when the trader wanted to close out his position, the bucket shop would give him back his money plus or minus the difference in price of the stock between the time the trade was started and ended.  (In practice, the bucket shops usually allowed trading on very thin margin, but we will ignore margin trading for now, as an unnecessary complexity that we don't need to discuss, for the purposes of this effort.)

The fact that the bucket shop collected the share price from the trader suggests that this arrangement is a permutation of class of debt arrangements I earlier referred to as “loans denominated in another asset.”  I say this because, though the bucket shop paid no interest on its “loan”, the bucket shop was able to take the money from the trader and put it to work in the form of a float to pay off any other traders who may have had successful trades against the bucket shop.  It may seem that I'm playing fast and loose with language, but I'm doing this intentionally.  Remember that, in the original post, I classified a carry trade as a type of short sale, even though I've never heard it described as that.  The reason I did this was because, as I went through the arrangement, I could see that a carry trade definitely involves the sale of a borrowed asset.  That qualifies it as a short sale, even though common usage does not involve the term “short sale” to describe a carry trade.  Likewise, here I am using unusual terminology to define a bucket shop bet as a no-interest loan denominated in another asset.

To elaborate, let's say that Jesse Livermore walks into a bucket shop in 1902 to place a bet on the price of shares of Bethlehem Steel.  There are two parties to this trade: Jesse Livermore and the bucket shop.  There are two assets pertinent in this trade: US dollars and shares of Bethlehem Steel.  This is a simple trade, as no interest is involved, no interpolated trades are involved, and the price change between USD and Bethlehem Steel creates the only profit/loss potential.

The bucket shop collects USD (in the amount equivalent to that necessary to buy shares of Bethlehem Steel) from Livermore, which the bucket shop can then put to work as float for other trades.  At the conclusion of the trade, the bucket shop will pay back the amount of USD equivalent to the value of shares of Bethlehem Steel at the time of closure of the trade.  This is an arrangement identical to the arrangement in my first post called “loans denominated in another asset.”  So, we can see that, even though this type of trade would not normally be considered a debt-based trade, in fact it is.

There could, of course, be another type of contract for difference, or bet, in which neither trader collects funds from the other.  Perhaps this is the type of arrangement that is described by Bytemaster.  If that is correct, then BitAssets would not be a debt-based arrangement.

Let's say that two traders, Alice and Bob, sit down at a card table, they each put down assets on the table.  Alice puts down USD, Bob puts down USD.  Alice and Bob both have opposing opinions on the future price of shares of Bethlehem Steel, so they draw up a contract.  Alice believes that Bethlehem Steel will fall in price, but Bob thinks it will rise in price.  At the start of the trade, Bethlehem Steel is trading for $100 per share.  Alice agrees to pay Bob $1 for every $1 Bethlehem Steel may rise in price, and Bob agrees to pay Alice $1 for every $1 it may fall in price.  No one collects money from the other.  They both just keep their USD sitting on the table, as if held in escrow.  At the close of the trade, Bethlehem Steel has fallen in price by $4.  Therefore, Bob pays Alice $4, and the trade is concluded.

This trade involves two people: Alice and Bob.  It involves two assets: USD and shares of Bethlehem Steel.  (Notice that, though shares of Bethlehem Steel are not traded, the price of these shares is integral to the trade.)  There is no interest consideration or interpolated trade.  There is no lending involved in this trade.  The only profit/loss potential of this trade is the change in price of Bethlehem Steel as compared to USD.  This is a simple trade; a bet.  Does the community believe that either of these arrangements most closely approximates the BitAssets arrangement?

Offline cass

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Re: BitAssets Article
« Reply #4 on: April 28, 2015, 08:10:13 AM »
In the history of the BitShares Forum, that's one of the best first postings I've seen by a new member (unless, of course, you changed your name). Welcome and good luck with your article.

 +5%

Welcome on board mhr !!!
from what i can see from backend ... not a changed name account .. but a new user :)
█║▌║║█  - - -  The quieter you become, the more you are able to hear  - - -  █║▌║║█

Offline gamey

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Re: BitAssets Article
« Reply #5 on: April 28, 2015, 05:59:49 PM »
Why not use modern CFDs in your analysis?  Why use bucketshops which were run like illegal gambling shops?  The level of creditworthiness between the markets can vary hugely.  A bucketshop vs a blockchain are basically as far apart as possible in terms of their counterparty risk.
« Last Edit: April 28, 2015, 06:01:31 PM by gamey »
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Offline hrossik

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Re: BitAssets Article
« Reply #6 on: April 28, 2015, 06:06:16 PM »
This trade involves two assets, but it does not involve a sale.  Also, this trade involves two parties, Alice and Bob.  This leads me to believe that BitAssets is basically a loan for which the denominating asset (USD) is different from the lent asset (BitShares).

I think when you want to short BitUSD, there must be somebody, who buys them. This way BitUSD is "shorted into existence". If you want to close the short, you then buy the amount of BitUSD and cancel the loan using them. So there is a sale of the borrowed BitUSD involved here. Also 3 parties are involved: you, somebody who bought your borrowed asset, and someone else, from who you need to buy the asset in order to repay your loan.

This is how I understand the mechanics. If it's not like this, I would appreciate correction :)
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Offline mhr

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Re: BitAssets Article
« Reply #7 on: April 29, 2015, 12:52:03 AM »
Thank you, Cass.  I am, and I am not, a new user.  Somewhere in the middle.  I think I posted under my first name a few times back in the Keyhotee days, just questions about setting up the client and such, but that seems like ages ago.  I had gotten sidetracked on other projects in the interim.

Thank you, BJ2.0, for the entertaining article.  You're right.  I don't think I can top that, so I won't try.  BitMarmots!

Gamey and hrossik, you ask just the questions to which I am trying to discover the answers.  I wrote a post last night just before I went to bed, but I didn't want to clutter up the thread with too many ideas at one time, so I held it back.  Your questions segue into what I wrote last night, so I will append it below this post.

The short answer, gamey, is that modern CFDs possess the very same problems that the bucket shops possessed.  There are fundamental problems with this arrangement, as I will demonstrate in my following post.  A modern, regulated financial system may improve on the betting arrangement which was offered by the bucket shops, and a blockchain might improve on the betting arrangement which was offered by the bucket shops, but neither can eliminate the intrinsic problems.  They improve by mitigating or eliminating some of the problems, but not all of them.  This is largely what Preston Byrne was talking about.  Arranging sophisticated trading systems is not easy.  However, he doesn't even go far enough, as he suggests it should be left to professionals.  However, even professionals bugger it up from time to time.  Just think about Collateralized Debt Obligations.

Some of the biggest financial institutions in the world participated in CDO debacle.  The arrangement collapsed as many predicted it would.  It was based upon flawed assumptions.  Houses and mortgages are never fungible.  Location, location, location!  When was the last time you heard someone say "location, location, location!" about gold?  Gold is fungible, houses are not.  Even though some actuarial science may be reasonably brought to bear on masses of mortgages for the sake of efficiency, it must always be remembered that houses, no matter how many houses they may be, are not fungible.  When this practice is pyramided on top of a housing bubble born out of fractional reserve banking, it is clear to see that this is an unworkable arrangement.  So, it had to implode.

Just because some major markets around the world allow for the trading of contracts for difference doesn't mean that people should trade contracts for difference.  Frankly, I think people should be allowed to trade whatever they want, and let the buyer beware.  Having said that, I would not be surprised to see the existing CFD arrangement fall by the wayside of the mainstream financial system at some point.  Afterall, it's just a fancy name for a bet.

Hrossik, to specifically answer your questions about how BitAssets work exactly, I can only say that I don't know.  I'm not sure than anyone does.  Maybe Bytemaster and some of the top developers understand it inside and out.  Or maybe they have let, for example, the Australian Stock Exchange do their intellectual work for them, and they have decided, "if it is good enough for the ASE, it is good enough for BitShares.  We'll just arrange it like the ASE does."  Of course, I can't know that.  But, if one cannot explicitly understand and describe every angle of a trading platform; every possible trading variation, any bear raid, any short squeeze, any off-exchange manipulation that is possible in reality or in the minds of creative speculators, one should not trade on that platform.  OK, I'll append last night's thoughts below.

Offline mhr

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Re: BitAssets Article
« Reply #8 on: April 29, 2015, 12:56:26 AM »
Putting aside definitions, for now, I'd like to bring up a couple of concerns about some possible threats to the BitAssets arrangement, one of them artificial, and the other more intrinsic.

As mentioned in the previous post, in the United States, neither bucket shops nor contracts for difference are legal.  Also, betting of all types is highly regulated.  As members of the BitShares community are located in the US, I see this as a real concern.  If BitAssets gets popular enough to attract the attention of regulators, is there going to be any risk to the US-based members of the community?

A problem more intrinsic to bucket shop bets and contracts for difference is the fact that trader's cannot stand for delivery of the underlying security or commodity.  This means that it is not possible for traders to call the bluff of a manipulator.  In the late 1970s when the Hunt brothers came to believe that silver prices were being manipulated on the highest levels, they began to buy silver futures contracts, and then stand for delivery, rather than closing out their positions for cash settlement.  The affect that such wealthy and aggressive speculators taking delivery of silver had on the futures market was an epic short squeeze.  Ultimately, to save the futures exchange, the shorting agents, and possibly to save the US dollar, regulators had to step in and halt the short squeeze.  This interruption of normal trade on the futures exchange must necessarily have hurt the credibility of the futures exchange, so powerful was the recourse available to the Hunt brothers.  Ultimately, the Hunt brothers were forced into bankruptcy, but only because the shorts were closer to the regulators than the Hunt brothers were.  If such actions had not been taken, it would have been the shorts going bankrupt, not the Hunts.

This recourse of taking physical delivery of the underlying securities or commodities does not exist in contracts for difference.  This is a big problem.  Let's go back to our earlier example of bucket shop bets for shares of Bethlehem Steel.  If traders want to place bets on Bethlehem Steel advancing against the USD, and a large trader, or the bucket shop, wants to take the other side of that bet, there is nothing to stop the bucket shop from selling real, exchange-traded shares of Bethlehem Steel in an effort to manipulate the bucket shop price for Bethlehem Steel.  I'll elaborate.

On a real exchange, such as the New York Stock Exchange, when someone buys or sells shares of Bethlehem Steel, those buy and sell orders factor into the market price as determined by supply and demand.  However, when one places a bet on shares of Bethlehem Steel in a bucket shop, that bet does not factor into the market price as determined by supply and demand.  The market has no knowledge of that bet.  The bet does not take existing shares of Bethlehem Steel off of the ask book.  It does not contribute any upward or downward pressure on the price of the real shares.  Therefore, it does nothing to resist price movement in the opposite direction.  This means that market manipulation of bucket shops is much easier and less risky than market manipulation of a stock exchange.

If interest in CFDs or bucket shop bets becomes great enough, it sets up an incentive for a large trader to enter the bucket shop market heavily on one side of the trade, and then to also enter the real exchange heavily on the same side of the trade.  The large trader can temporarily manipulate the real exchange with no resistance from the bucket shop market, push all the opposing bucket shop traders out of their positions, take profits off the table in the bucket shop, and close out its positions on the real exchange.  This would be a temptation too great to ignore.  It would be like shooting fish in a barrel.  Of course, this is a greater risk if the bucket shop allows trading on margin, but it is still a concern even if the bucket does not allow trading on margin.  There is no way for the bucket shop traders to call the bluff of the manipulator.

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Re: BitAssets Article
« Reply #9 on: April 29, 2015, 01:48:25 AM »

 Excuse me for being here post "Keyhotee days", but if I can ask a question?

 What is wrong with the perfectly legal option contracts (in USA) , which prices does not move (contribute to the movement of) the underlying asset price (be it stocks or futures)?

Where does this fit in your line of arguments?

Offline mhr

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Re: BitAssets Article
« Reply #10 on: April 29, 2015, 05:50:44 AM »
Tonyk2, you ask a great question.  One may exercise an option contract.  In the world of hedgers, this is routine.  In the world of speculators, this is the exception.  I'll copy and paste here from Investopedia:

An option is a contract that gives the buyer the right, but not the obligation, to buy or sell an underlying asset at a specific price on or before a certain date.

Me again:  the underlying asset is available to the purchaser of an option.  This is very important.  The underlying asset is not available to the purchaser of a bet... or a contract for difference.

That may seem like a trifling difference, but it is an enormous difference.  Really, it is the whole difference.  I'm failing to be articulate, because I am sleepy, but I will address this tomorrow.  Thank you for your question.

Offline gamey

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Re: BitAssets Article
« Reply #11 on: April 29, 2015, 11:03:19 PM »
I do not believe that Tony fails to know what are options. He was pointing out that when people purchase options there is not necessarily pressure or resistance from the underlying asset because assets are not exchanged. That seemed to be the crux of your argument against CFD's and why they are bad.  If CFD's enable manipulators, why don't options?
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Offline Ander

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Re: BitAssets Article
« Reply #12 on: April 29, 2015, 11:30:08 PM »
The discussion on options and convertability shows why gateways are important.

That is, a bitGold is a lot more useful if you can convert it into a physical gold, thus Cryptosmith is important.  A bitUSD/bitCNY is a lot more useful if you can convert it directly into a normal USD/CNY.  Thats why fiat gateways are important.
https://metaexchange.info | Bitcoin<->Altcoin exchange | Instant | Safe | Low spreads

zerosum

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Re: BitAssets Article
« Reply #13 on: April 30, 2015, 12:07:49 AM »

Me again:  the underlying asset is available to the purchaser of an option.  This is very important.  The underlying asset is not available to the purchaser of a bet... or a contract for difference.


You are making my case man - in BTS the underlying is available to 'purchase' or get...
 The short bitUSD is the right to purchase (get) more BTS if the price of BTS goes up compared to bitUSD. If you short and you are right about the price you get more BTS when you close your short position.

Offline merivercap

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Re: BitAssets Article
« Reply #14 on: April 30, 2015, 07:29:24 AM »
mhr,
Thanks for your post and providing fascinating historical context. 

1)
There could, of course, be another type of contract for difference, or bet, in which neither trader collects funds from the other.  Perhaps this is the type of arrangement that is described by Bytemaster.  If that is correct, then BitAssets would not be a debt-based arrangement.

Let's say that two traders, Alice and Bob, sit down at a card table, they each put down assets on the table.  Alice puts down USD, Bob puts down USD.  Alice and Bob both have opposing opinions on the future price of shares of Bethlehem Steel, so they draw up a contract.  Alice believes that Bethlehem Steel will fall in price, but Bob thinks it will rise in price.  At the start of the trade, Bethlehem Steel is trading for $100 per share.  Alice agrees to pay Bob $1 for every $1 Bethlehem Steel may rise in price, and Bob agrees to pay Alice $1 for every $1 it may fall in price.  No one collects money from the other.  They both just keep their USD sitting on the table, as if held in escrow.  At the close of the trade, Bethlehem Steel has fallen in price by $4.  Therefore, Bob pays Alice $4, and the trade is concluded.

This trade involves two people: Alice and Bob.  It involves two assets: USD and shares of Bethlehem Steel.  (Notice that, though shares of Bethlehem Steel are not traded, the price of these shares is integral to the trade.)  There is no interest consideration or interpolated trade.  There is no lending involved in this trade.  The only profit/loss potential of this trade is the change in price of Bethlehem Steel as compared to USD.  This is a simple trade; a bet.  Does the community believe that either of these arrangements most closely approximates the BitAssets arrangement?
 
Yes.  That's exactly it. 

2)  It's based on the ideas of a CFD, more specifically a Total Return Swap.

3)  In your original 'shorting' example, it's good to explain the other side.  When Bob sells the borrowed asset and the asset increases in value, Bob needs to pay more to purchase the 'shorted' asset before returning it to Alice.   Hence Bob needs collateral and has margin requirements to short an asset.  Also in a typical short transaction, the brokerage firm acts as the 'bucket shop', since it use the cash proceeds of a short sale and floats it for interest. 

4) One party to a CFD/Total Return Swap is functionally equivalent to being the 'long', and the other party the 'short'.

5) In regards to financial regulations of CFDs, it's no different from trading stocks or any assets.  They're functionally equivalent.  One party generally thinks an asset is going up.  One party generally thinks the same asset is going down.  And then they trade.  You can trade actual stocks, commodities or CFDs and you can consider them all bets.  It's the same with trading Dogecoin for Bitcoin.   Note: people also use real assets and CFDs to hedge exposure as well as diversify risk so there are some other reasons to make a trade.  I've heard some people even buy & hold companies for long term future cash flows.   :P

FYI: Have you read Michael Lewis's the 'Big Short'?  It describes the whole mortgage crisis very well.  Michael Burry, John Paulson and some young no-name investors just out of college knew housing was in a bubble and made big bets with unconventional methods and succeeded.  Burry wanted to find the best way to short housing.  He was so eager to find a way he connected with Goldman Sachs and convinced them to sell him credit default swaps on the 'short side' of subprime loans, effectively a CFD that Goldman sold to big banks on the 'long side' who wanted yield and thought housing would go up forever.  These credit default swap CFDs gave each party the exposure they wanted.  Neither Burry nor the banks had expectations of delivering underlying mortgage securities.  They were all just bets.  Burry who wasn't a 'Wall-street' guy went on to make $700+ million for his investors.  The young no-name investors found a way to make millions as well.   It's interesting that a few people from main street were able to beat Wall Street and the bankers at their own game with these investment vehicles.  Of course the government went on to bail out the poor Banks & Wall Street.

6) 
  If traders want to place bets on Bethlehem Steel advancing against the USD, and a large trader, or the bucket shop, wants to take the other side of that bet, there is nothing to stop the bucket shop from selling real, exchange-traded shares of Bethlehem Steel in an effort to manipulate the bucket shop price for Bethlehem Steel. I'll elaborate.

On a real exchange, such as the New York Stock Exchange, when someone buys or sells shares of Bethlehem Steel, those buy and sell orders factor into the market price as determined by supply and demand.  However, when one places a bet on shares of Bethlehem Steel in a bucket shop, that bet does not factor into the market price as determined by supply and demand.  The market has no knowledge of that bet.  The bet does not take existing shares of Bethlehem Steel off of the ask book.  It does not contribute any upward or downward pressure on the price of the real shares.  Therefore, it does nothing to resist price movement in the opposite direction.  This means that market manipulation of bucket shops is much easier and less risky than market manipulation of a stock exchange.

If interest in CFDs or bucket shop bets becomes great enough, it sets up an incentive for a large trader to enter the bucket shop market heavily on one side of the trade, and then to also enter the real exchange heavily on the same side of the trade.  The large trader can temporarily manipulate the real exchange with no resistance from the bucket shop market, push all the opposing bucket shop traders out of their positions, take profits off the table in the bucket shop, and close out its positions on the real exchange.  This would be a temptation too great to ignore.  It would be like shooting fish in a barrel.  Of course, this is a greater risk if the bucket shop allows trading on margin, but it is still a concern even if the bucket does not allow trading on margin.  There is no way for the bucket shop traders to call the bluff of the manipulator.
 

 I think you bring up a fantastic point about historical manipulation in the bucket shops.  The bitUSD/BTS internal market is somewhat like a bucket shop exchange.  I think your historical evidence shows how a market like BitShares can potentially be manipulated.  However I think your conclusion about what went wrong in the bucket shop is not correct.  The reason the bucket shops could manipulate trade is that they had knowledge of an additional large order book and vulnerable margin positions, not because traders weren't able to call bluffs or request the delivery of an underlying asset.  I bolded your first statement.  The bucket shops could manipulate the price in the real exchange to effect the outcome in the bucket shops.  That is not easy, but that's probably what they did when with the additional market info they had.  In the bitShares system, the order book for the 'bucket shop' and 'real exchange' is public so no one has extra info on the market.   However the current external market and price feeds can be manipulated because Bitshares is illiquid and until there are more trusted exchanges and better price feeds there is still room for manipulation.   Hence it is not the nature of the CFD that is a problem with the BitShares system, but the infancy of the market and ecosystem. 

7.  Furthermore, the original bitAssets had design flaws.   There is an imbalance against long BTS holders in favor of long bitUSD (short BTS).   Requiring 200% collateral and forcing settlement magnifies the pressure against those long BTS (short bitUSD) especially in a severe bear market.

8.  The good thing is Bytemaster and the BitShares developers have learned from experience and collaborate with the community to improve and refine the system.  BitAssets 3.0 may have issues and parts I don't agree with, but it is a significant step in the right direction and there will probably be future refinements as we move forward. 
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